Simple reasoning will suggest using savings to pay off debt. However, Quick Loans Express explores whether to save or pay off debt.
Should I Save or Pay Off Debt?
We all like having money put by for a rainy day or to save up for something we want. However, at the same time, we might use consumer credit to make purchases. This could be in the form of an overdraft, a same day loan and/or through the use of credit cards or store cards. How do we know when we should save or pay off debt you have accunulated?
In this article we look at the reasons you should use your savings to pay off your debts and when it isn’t a good idea. We also answer the question – what should you do if your savings aren’t enough to pay back all the money you’ve borrowed?
Things to Consider Before Deciding to Save or Pay Off Debt
What’s the Interest Rate?
The first thing you should do is to calculate the interest rate on your debts. In effect, this is how much the bank is charging you to borrow money from them. Then you should calculate the interest rate the financial institution gives you as a reward for saving with them. Let’s take a very simple example to illustrate my point:
£1,000 of debt at an interest rate of 19% means you pay fees of £190.
£1,000 of savings at an interest rate of 1.5% means your money earns £15.
Therefore, you can save £175 by using your savings to pay off your debts.
Income Tax on Personal Savings
Another reason to use your savings to pay back the money you’ve borrowed is if you earn large amounts in interest. Since April 2016, the Personal Savings Allowance is £1,000. If the amount you earn in interest is this amount (or higher), you should use some of the capital to pay off your debts. If you don’t, you’ll be charged income tax on it.
When it Doesn’t Make Sense to Use Your Savings to Pay Off Debt
Balance Transfer Deals
One reason why it wouldn’t be worth paying off all your debts with your savings is when you’re on a balance transfer deal for credit cards. The interest-free period could be as long as 28-38 months. In this case, wait until the term of paying no interest on your credit card’s outstanding balance comes to an end and re-evaluate your decision.
Penalties for Early Repayment
Certain credit facilities such as personal loans have penalties and fees for early repayment. Therefore, you should check their terms and conditions before you pay them off. In this situation, paying bank charges might wipe out any savings you make on interest in the long-term. Therefore, you should wait until these fees come down. This is usually nearer the end of the loan period.
Easy Access to Credit in the Future
Some people consider their savings to be their safety net. It gives them greater peace of mind knowing that they have a sum of money put by just in case they have unexpected expenses and need money in an emergency. Of course, financial advisors often emphasise the fact that we should all have a rainy day fund put by, but this is mainly for those who have no debts. It’s much better to pay off your debts first and then start building up savings for the unexpected. If you do need money in a hurry during this period without savings, then you could always borrow again.
The only exception to this rule is if you would find it difficult to access credit if you paid off all your debts. If you have a small personal loan, for example, there’s no guarantee that the financial institution would lend money to you again. Therefore, you shouldn’t dip into your rainy day fund.
What If Your Savings Aren’t Enough to Pay off Your Debt?
You might be in a situation where you have a lot of debt in the form of credit cards, store charge cards, an unsecured payday loan and an overdraft. It might be possible that your savings are insufficient to pay off all the money you owe. In this situation, is it worth even trying to reduce your debts?
In this case, you should prioritise your debts and compare their interest rates. Use your savings to pay off the ones with the highest rate first and then pay off the others.
Once you’ve cleared some of your debts, the amount you have to repay every month will go down. Don’t use this as an excuse to spend this money. Instead, put it towards increasing the repayments for your other debts. In this way, you’ll be able to pay off the debts much faster.
Shold You Save Or Pay Off Debt?
Your main priority should be paying off the sums of money you’ve borrowed before you can really start putting money by for a rainy day. However, you should only do this if you pay more in interest than the savings interest rate, pay no penalties for early repayment and if you will still have access to credit in a future emergency.